May 13, 2024 - Business

Why second mortgages could make a comeback

Illustration of a front door with a dollar texture

Illustration: Natalie Peeples/Axios

Freddie Mac has a new revenue stream in its sights, thanks to the record $17 trillion of home equity sitting untapped in U.S. houses.

The big picture: An estimated $850 billion of that home equity is found in homes with first mortgages that were purchased by Freddie Mac — a so-called government-sponsored enterprise, or GSE. Freddie wants to start buying second mortgages written on those homes.

Why it matters: If Freddie's proposal is approved, a GSE-backed market for second mortgages could stimulate more lending and funnel more money to consumers. The catch, of course, is that any default would put those consumers' homes at risk.

Where it stands: Freddie's regulator, the Federal Housing Finance Agency, seems likely to approve the idea, noting that "second mortgages are typically offered at a lower interest rate than some financing alternatives such as consumer or personal loans."

The intrigue: Some folks in the financial services industry are worried this will be a success.

  • The fingerprints of a lowkey PR operation can be seen in this WSJ op-ed, and also a two-page document of talking points sent to Axios complaining that Freddie's plan could cause everything from high inflation to worsened wealth inequality. (The sender of the pitch, Narrative Strategies, declined to say who they're representing.)
  • The potential losers in Freddie's plan include firms currently securitizing second mortgages, as well as consumer lenders who would face new lower-priced competition.

How it works: Freddie has always bought new mortgages resulting from cash-out refinance operations. In the current high-rate environment, however, those loans are barely issued since they require swapping out a lower-rate older mortgage with a higher-rate new one.

  • A second mortgage effectively replicates the cash-out refinance while applying the new, higher rate only to the increase in principal amount.
  • It's different from home equity lines of credit, or HELOCs, in that it's fixed rather than floating rate, and feels more like a long-term commitment than a short-term source of liquidity.

What's next: The results could be big enough to stimulate the entire U.S. economy, per analyst Meredith Whitney, who writes that the "move could begin to unleash almost $1tn into consumers' wallets."

The other side: Bank analyst Chris Whalen, on the other hand, suggests that it's more likely to be a complete nothingburger.

  • For one thing, it's hard to imagine how anybody would market a product based on this, given that no one has a clue whether their mortgage is held by Freddie Mac. (The agency wants to ensure that if it faces a default on a second mortgage, it owns the first mortgage as well, to maximize its chances of being paid back on both.)
  • The product being envisaged — a 20-year second mortgage — would also not be very profitable for lenders, who ultimately make most of their money not by flipping loans to Freddie but rather from mortgage servicing rights.
  • Those rights on second mortgages "have little value because of the small note size," writes Whalen.

The bottom line: It's unlikely that allowing Fannie and Freddie to buy second mortgages would unleash trillions of dollars of new credit into the economy. But it's not impossible.

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